Global Economics

The Economic Fallout From Bombing Iran

“Nobody’s announced a war, young lady,” President Barack Obama said in New York on March 2, wagging his finger at an audience member who decried the possibility of U.S. military action against Iran. “But we appreciate your sentiment.” The crowd cheered, and a smile crossed the president’s face.

It’s too soon to say when, or whether, the long-simmering dispute over Iran’s nuclear program will erupt in armed conflict. “There is still a window that allows for a diplomatic resolution,” Obama said before meeting with Israeli Prime Minister Benjamin Netanyahu on March 5. A raft of Western economic sanctions against Tehran, including a looming embargo on Iranian oil exports to the European Union, has made the country’s rulers more willing to “recommence negotiations without preconditions, which isn’t something they were amenable to last year,” according to Karim Sadjadpour, an Iran analyst at the Carnegie Endowment for International Peace. War with Iran in 2012 “is plausible but not probable,” he says.

The economic case against war is strong. Jitters about instability in the Middle East have caused the price of Brent crude to rise some 9 percent since the beginning of the year. Even a limited conflict with Iran—the second-largest oil producer in the Organization of Petroleum Exporting Countries, after Saudi Arabia—would jack up insurance premiums on oil tanker traffic through the Persian Gulf. Iran exports 2.5 million barrels per day, and OPEC lacks the spare capacity to make up for the likely loss of Iranian supply in the event of an attack, according to Robert McNally, president of the Rapidan Group, an energy consulting firm. That’s a formula for an oil shock far more painful than what global consumers are currently experiencing. “What we see now is a market that is very fearful and very tight,” says McNally, a former senior director for international energy at the National Security Council. “In those conditions, it doesn’t take much to send the cost of oil soaring.”

Just how high prices might climb if war breaks out, and the broader consequences to the world economy, depend on two factors: whether military action is initiated by Israel or by the U.S., and how Iran responds. A strike conducted by Israel, which has limited air power, might be over in a matter of hours. It would target the four main Iranian nuclear facilities the world knows about, but there’s no guarantee that Israel’s bombs would be able to penetrate Iran’s deepest underground sites. An attack carried out by the U.S. military, on the other hand, would be longer and more extensive, according to Matthew Kroenig, a nuclear security expert at the Council on Foreign Relations. He believes a two-week U.S. bombing campaign could wipe out not just Iran’s nuclear program but also its air defenses and some missile capabilities. The Pentagon’s newest generation of 30,000-pound “bunker-buster” bombs are thought to be capable of pulverizing targets as much as 200 feet below ground. “There’s a lot of confusion between what an Israeli strike would do and what an American strike could do,” Kroenig says. “Israel would set Iran’s nuclear program back between one and three years. The U.S. can set it back 10 years.”

The costs of doing so could be steep, however. If the U.S. attacks, “the Iranians might feel they have less to lose” by retaliating aggressively, says Michael Makovsky, foreign policy director of the Bipartisan Policy Center in Washington. Tehran might attempt to sabotage oil facilities in Saudi Arabia and southern Iraq, launch missiles into Israel, or deploy small attack vessels to harass tankers in the Arabian Sea. The nightmare scenario would be a move by Iran to choke off access to the Strait of Hormuz—most likely by unleashing its stockpile of 2,000 mines—through which as much as 40 percent of the world’s seaborne oil travels. The U.S. has warned that such a step would provoke an all-out assault on Iran’s military. Would Tehran take that risk? “If Iran concluded its regime were threatened, it might try to make the conflict as big as possible, as quickly as possible, to bring other powers in to mediate,” says McNally.

An analysis by the Rapidan Group predicts that a targeted airstrike on Iran, followed by a token Iranian response, would cause oil prices to jump $23 a barrel before settling back down. (As of March 6, Brent crude was trading at $122 a barrel.) A more protracted conflict, if it involved even a brief closure of the strait, might cause oil prices to spike by more than $60 a barrel. “It would be the biggest geopolitical disruption in the history of the global oil market,” McNally says. Ed Morse, global head of commodities research at Citigroup (C), estimates that if oil were to reach $150 a barrel, the U.S. would lose two percentage points in economic growth, enough to turn the nascent recovery into a recession.

The dilemma for the Obama administration is that the alternatives might be even worse. “If we don’t have this confrontation now, but we end up with a nuclear Iran, we have to factor in the consequences of dealing with a nuclear arms race in the Gulf,” says Anthony Cordesman of the Center for Strategic and International Studies. At a minimum, the Pentagon would need to invest in new anti-missile technologies and maintain a sizable footprint in the region, just as it is winding down two wars there. “It could have a major impact on the U.S.’s interest in reducing defense spending,” says Cordesman. And because a nuclear Iran would make the Middle East and the world less stable, living with the bomb also means living with higher oil prices for an indeterminate future. “The worst outcome for the global economy, by far,” says McNally, “would be a hostile, nuclear-armed Iran.”